Do you only make the minimum payments on your credit cards?
If money is tight, you may feel you can’t afford more…
But do you know that there is a simple alternative that will speed up debt repayments a lot, not harm your credit record and not cost you any more?
How long does it take to clear the balance?
Suppose you buy a cot, buggy, car seat and some other baby equipment costing £1,200 on a new credit card.
It’s at a rate of 18% and the minimum payment will start at £28 a month – that’s using pretty common minimum repayment rules. You think that sounds OK.
Here is how long Barclaycard says it would take to repay that £1,200 if you only pay the minimums:
So it will take nearly 20 years to finish paying for all the baby equipment. And you will have paid more in interest than what you bought.
Making minimum payments to a credit card is a trap!
Paying the minimum to credit cards or catalogues takes an astonishingly long time to pay off a credit card.
Most of your payment is just paying the interest, only a little is repaying the money you owe. With many credit cards that repayment amount is set at 1% of your balance per month.
But the real problem is that because you will have paid off a tiny bit of the balance, next month the 1% balance part will reduce. So your next minimum payment is a little bit less. Not enough to really help you, you probably won’t even notice it.
You might think that’s good – but it is actually a trap!
You are paying off less of the balance every month. So the time to clear the balance stretches out and you are kept paying interest for longer.
That interest adds up to a lot. Looking at this problem, the FCA said:
firms have few incentives to help these customers because they are profitable.
“20 years? Really? That shouldn’t be legal!”
It certainly isn’t what most people would expect to happen. But it’s not an exaggeration.
Those are Barclaycard’s figures. And the interest rate I used wasn’t particularly high. If you borrow more, it will take even longer.
Here is Barclaycard’s minimum payment calculator. If you put in a balance of £2,500 and an interest rate of 20%, it would take you 26 years to repay the debt.
The FCA is making banks and card companies write to people who have been making minimum payments for too long and suggest they should pay more.
After three years of making minimum payments, if you can’t afford to pay more, the lender has to look at options such as lower interest rates, charges and fees… but this would probably be recorded on your credit record as an Arrangement to Pay which would harm your credit score for years.
So what can you do to get out of this trap and not harm your credit score? It would be great to be able to pay off your whole bill in a few months, but for many people that isn’t realistic.
The simple solution when money is tight – start paying a fixed amount
If you are thinking I can only afford the minimum amount you can choose to always make your current repayment, instead of letting it drop a little bit each month.
This is a simple approach, which won’t cost you any more, but which can make a dramatic difference.
BUT you must also stop using the card if you do this. If you don’t, your minimum payments may increase because of your new purchases. If you have fixed them at the previous level you will get behind and it will affect your credit record.
Doing this one simple thing makes a big difference!
Use the above example – you have a £1,200 balance on your card. The Barclaycard calculator has a “fix your payment” button you use to see what effect this has.
If you decide to fix your monthly card payment at £28, your current minimum payment:
- it will take you 5 years and 6 months to clear the balance
- you will have paid £635 in interest.
Doing this isn’t going to cost you any more now, but it will take 14 years off the time you are paying interest, and mean you pay less than half as much interest.
So if you can switch to paying a fixed amount instead of the minimum, it’s not going to be expensive for you, but you will be out of debt many years sooner.
Paying even a little bit more can have a surprisingly large effect
Can you afford to pay an extra £2 a month, so £30 to that £1,200 balance? Fixing your payments at that level will mean your credit card balance is paid off even faster:
- it will take you 4 years and 11 months to clear the balance
- you will have paid £563 in interest.
How to “fix a payment”
If you want to always pay the same amount to your credit card, you can set up a standing order to do this. Your credit card will tell your their sort code and bank account number to use – and you normally use your card number as the “payment reference”.
If you get paid monthly, it could be good to pay the credit card as soon as you are paid. If you talk to the credit card, they will often let you change the payment date.
A good idea even on 0% cards!
If you have a card you are currently paying 0% on, it’s still a good idea to fix your repayments, preferably at more than the current minimum. The ideal is to fix the payments at an amount that will clear the balance by the end of the 0% period.
It is getting harder to get good 0% balance transfer deals. They are getting shorter and the credit limits are being reduced. So the more you can pay off the balance, the less chance there is of problems at the end of the 0% deal. Also paying more than the minimum is shown on your credit record and can increase your chance of getting credit in the future.
You do need to stop using the card!
Of course fixing your payments only works if you stop using the card. If you set up a standing order for £30 and then go and spend a lot more, you will be paying less than the minimum amount and this will harm your credit record.